Open Banking: How big banks can overcome the challenges of PSD2

PSD2 is a European regulation for electronic payment services, created to make payments more secure and enable banking services to adapt to new technologies. For the banking sector, compliance represents a key milestone in the continued evolution of open banking to improve customer authentication processes.

For instance, the implementation of Strong Customer Authentication (SCA) requires merchants and Payment Service Providers (PSPs) to work together with technology suppliers, card schemes and many others to deliver SCA in a way which works well for customers. The challenge, however, is that the legacy technology systems that a lot of banks rely on are not geared towards compliance. 

This raises a key question: how can organisations turn a regulatory burden into an opportunity to compete, innovate and grow? To answer this question, let’s step back for a second and examine the context. 

PSD2 is the EU Directive that paved the way for open banking and is a follow-up to PSD, the payment services directive that arose from SEPA, the EU's Unified Payments Authority, whose mission was to unify payments across the EU. PSD2 is, in many ways, the aim that was originally set out in PSD - it lays out what the EU wanted the financial sector to accomplish in order to empower consumers and unite the financial ecosystem so that all stakeholders could simply and securely communicate with one another.

PSD2 gave financial institutions a set of objectives to meet, but part of the challenges was that it never specified a solution, and certainly not one that used APIs. 

It wasn't until the industry began trying to solve the problem that it became evident that APIs were the way to go. The answer to how to meet PSD2 legislation was open banking standards, which are based on APIs.

PSD2 is significant because it revealed a digital divide between industries. For instance, tourism, transportation, manufacturing, and other industries were quick to digitise and work in sync with consumers' digital lives. 

The financial sector, however, was different, with consumers still required to attend branches in person to do the paperwork for products such as loans and mortgages.

It also says that consumers have a right to their data, which is not something that all open banking movements have done. For the first time, legislation set out that certain types of data (such as financial) belonged to the user who created it. 

This sparked a series of intense debates among European legislators about what it means to own your data and what rights individuals have to it, particularly in terms of leveraging it to create value and transferring it around - a concept known as 'portability.'

A change of mindset

The single most important challenge this creates for banks is that it requires a change of mindset. 

Historically, most banks expected that each customer would have all of their banking and financial services needs addressed by their institution. In doing so, they would stay in that bank's ecosystem as much as possible, and competition would focus on wallet share or product-per-customer targets.

The problem with this approach is that it assumes that each bank can fully meet all of an individual’s specific financial services requirements with the best products. However, this is increasingly at odds with today’s digital societies, where diverse customer requirements mean it’s simply not practical for a single institution to provide its customers with everything they could possibly want or need.

Here’s where the shift in mindset is needed so that banks can operate within a diverse and vibrant ecosystem of financial services. Part of this requires that they work with customers to help them live their digital lives, so whenever they need banking services, they are readily available and fully integrated into a system of “embedded finance”.

To bridge this gap, banks also need to think of themselves as technology companies and financial platform providers. For example, implementing an API-first strategy enables systems to talk to each other and deliver an effective interface between different software components and crucially, developers. As a result, consideration needs to be given to the developer experience to ensure each API is easy to use and understand and incorporate into their own code as part of an effective development process.

Ultimately, open banking represents a future where consumers understand that their data not only has utility but also they also have the right to move it around in ways that are transparent, secure and enforceable. Banks will continue to play a crucial role in driving innovation – the approach they take will determine how soon their customers see the benefits.

The views and opinions expressed are not necessarily those of AltFi.